Maze of financial regulation may distort competition

ECONOMICS: Banks believe proposed regulatory reforms could lower economic growth and lead to 10 million jobs being lost, writes…

ECONOMICS:Banks believe proposed regulatory reforms could lower economic growth and lead to 10 million jobs being lost, writes PAT McARDLE

THE RECENT crisis has resulted in international efforts to (i) strengthen bank regulation; (ii) improve co-ordination among bank supervisors; and (iii) develop resolution (ie bank wind up) and compensation systems. The G20, the Financial Stability Board, the Basel Committee on Banking Supervision, the European Commission and the Committee of European Banking Supervisors have all been active in this area.

The above, slightly modified quote, is taken from Banking Supervision: Our New Approach issued by the Central Bank last Monday. The bank says supervisors in other states have also launched initiatives which is precisely what the Irish regulator was doing.

It could have added that governments are also active, changing the regulatory architecture and shuffling the cards in the deck, just as our Financial Regulator has again been merged back into the Central Bank.

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It will be immediately obvious that there are many fingers in the regulatory pie. Keeping abreast of the paperwork alone is a mammoth task. The work is far from complete. Some regulators are jumping the gun and the lack of agreement risks creating a Tower of Babel.

The newly-enlarged G20 was the first to respond to the crisis; it charged the Basel Committee on Banking Supervision (BCBS) with bringing forward (voluntary) proposals to improve the prudential regulation of banks as earlier rules known as Basel I and Basel II had clearly failed.

The BCBS published its proposals for reform last year. Key elements include:

(i) capturing all the risks – trading book, securitised and off-balance-sheet exposures required surprisingly little capital under the old system;

(ii) differentiating in respect of systemically important banks to partly address the “too big to fail” problem;

(iii) improving the quality of capital principally by substantially raising the amount of common equity required;

(iv) a leverage or relative indebtedness ratio – this is a backstop at individual bank level designed to avoid another blow out of balance sheets;

(v) a liquidity ratio to link lending capacity to deposits and to ensure banks could cope with a limited run on deposits.

The risk is that these proposals are used in different combinations in different countries, creating disorderly regulatory competition.

A major row has already broken out over the impact of Basel III with the BCBS initially holding that its, yet to be quantified, proposals would have a negligible impact on economic activity but the banks are contending that euro zone growth would be lowered by almost 1 per cent per annum until 2015 with 10 million jobs lost globally.

European banks said they would face huge capital and liquidity shortfalls – possibly as much as €500 billion of each – reminiscent of the situation here against a background where banks are finding it increasingly difficult to tap the markets. Profits would be reduced by large double-digit percentages, possibly as much as 50 per cent.

The BCBS subsequently upped its estimate of the negative impact on global growth to a cumulative 1 per cent of GDP and now envisages extending the implementation deadline beyond 2012 which was the original plan. France, Germany and Japan are reported to be seeking a 10-year transitional period, much longer than either the US or Britain would wish. The European economy relies on bank lending to a much greater extent than the US, and French and German business leaders have weighed into the debate, saying the changes would be catastrophic.

Despite a promise to work out new rules together, several G20 members have charged ahead and announced measures without consulting their partners – for example, the US administration’s Volcker rule which would prohibit banks from owning hedge funds and limit their trading in derivatives, the German ban on short selling, the EU’s alternative investment directive and the UK’s bonus and bank levies, not to mention the recent Irish initiatives.

In particular, the G20 is split on the question of bank taxes. Countries like the US, Britain and Germany, which had to bail out their banks, are all in favour while others, such as Canada and Australia, see such levies as punishment for their banks which were left relatively unscathed by the credit crisis.

Back in October 2008, the EU asked former French central banker Jacques de Larosière to advise on the overhaul of financial supervision. In September 2009, and in response to de Larosière, the European Commission published proposals to create a new European Systemic Risk Board which will warn of threats to financial stability at either European or national level. There will also be a European System of Financial Supervisors to oversee individual banks even though day-to-day supervision will remain with national regulators.

In addition, the EU is looking at many other things including credit rating agencies, bank bonuses, stress tests, bank levies, resolution mechanisms, trading in derivatives, etc, most of which have yet to come to fruition.

Beside plans to restrict banks’ trading activities, the US House and Senate financial regulation Bills, which are currently being merged, would govern previously unregulated derivatives blamed for helping spread the troubles, create a mechanism for liquidating large firms, control bankers’ bonuses and establish a consumer protection agency to police lending, credit cards and other bank-customer transactions.

A new framework for financial regulation in the UK was unveiled last week. First, responsibility for banking supervision will be placed with the Bank of England (rather than with the Financial Services Authority which is being abolished). Second, the authority’s role as consumer and markets watchdog is to be transferred to a new body – the Consumer Protection and Markets Authority.

Third, the Bank of England will get a new policy arm: “macro-prudential policy”. This will be exercised by a new Financial Policy Committee, operating in parallel to the Monetary Policy Committee. Many issues have yet to be resolved – not least this new committee’s mandate. Whether it will focus on basics such as credit growth, or try to identify (and pop) asset bubbles is yet to be determined, as are the tools that will be placed at its disposal.

There are many dots on the international financial regulatory map: as yet, few of them are joined up.